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In hiking rates, Fed keeps one eye on economy, one on Trump

Federal Reserve Chair Janet Yellen holds a news conference following day two of the Federal Open Market Committee (FOMC) meeting in Washington, U.S., December 14, 2016


The Federal Reserve raised official U.S. interest rates for the first time in a year and signalled an accelerated pace of further rate increases, in a repositioning of monetary policy that has one eye on a growing economy and another squarely on the incoming Donald Trump presidency.

In its final interest-rate decision of the year, the U.S. central bank raised its official policy rate, the federal funds rate, by one-quarter of a percentage point, to a range of 0.5 to 0.75 per cent. The long-awaited follow-up to last December's quarter-point increase was near-universally expected by financial markets, reflecting the continuing strong growth in the U.S. labour market, a rebound in economic growth in the second half of this year, and rising inflation indicators. In her press conference after the rate announcement, Fed chair Janet Yellen called the rate hike "a vote of confidence in the economy."

But in the quarterly economic and interest-rate projections that accompanied the rate decision, the members of the Fed's powerful policy-setting Federal Open Market Committee signalled that they are now leaning toward three more quarter-point rate hikes next year, rather than the two that the majority of them had in mind in their previous projections in September – even though their forecasts for economic growth, unemployment and inflation had changed very little from the September outlook. While Ms. Yellen played down this acceleration in the rate path as "a very modest adjustment," it appears the Fed is bracing itself for Trump administration spending plans that could stimulate an economy that isn't in desperate need of fiscal stimulus.

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"Some of the [committee] participants, but not all of the participants, incorporated an increase in fiscal policy" into their economic and rate outlooks, Ms. Yellen acknowledged.

"But of course, the outlook is uncertain," she said, in reference to "economic policy changes" from the incoming president that could affect the U.S. economy.

And while Ms. Yellen stressed that "I'm not going to offer the incoming president-elect advice on how to conduct policy," several of her comments during her news conference indicated that she and Mr. Trump are at odds over key elements of his economic campaign promises – which, given Mr. Trump's unfavourable assessment of the Fed chief during the election campaign, suggests the tensions between the two aren't about to disappear.

When asked about Mr. Trump's proposed tax cuts and spending plans that many observers anticipate would deliver considerable stimulus to the U.S. economy, Ms. Yellen replied, "I would say at this point that fiscal policy is not necessarily needed to provide stimulus to return to full employment," noting that with the unemployment rate at a nine-year low and other indicators of employment quality much improved, the U.S. labour market is already running near full speed. She did allow that certain types of spending that would generate longer-term productivity gains – such as investments in public infrastructure, training and education – could be beneficial to the economy's capacity for growth.

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But the underlying message, though she didn't spell it out, was that in the short term, increased spending in an economy already near its full labour capacity would be inflationary, especially on wages, a critical trigger for broader inflation. That view certainly explains why the Fed is now positioning for somewhat higher rates next year, to help offset those inflationary pressures and keep the economy from running hotter than it is comfortable with.

The new rate outlook triggered a jump in government bond yields and the U.S. dollar, and the financial markets reacted to the expectation that the Fed would ramp up the pace of its rate hikes next year. The Canadian dollar lost nearly a half-cent (U.S.) against its U.S. counterpart shortly after the Fed's announcement, and closed the day at 76.20 cents (U.S.), down 0.02 cents on the day.

Ms. Yellen was also adamant that she opposes the dismantling of the Dodd-Frank regulations designed to better safeguard the financial sector against another 2008-style banking crisis – something the incoming Trump team has been considering, amid charges that the regulations have hurt the financial sector and stifled business growth. She said the "devastating" 2008 financial crisis made it clear that new regulations were essential to keep the financial system more secure.

"That's what Dodd-Frank was designed to do," she said, adding that the implementation of key requirements such as stress tests and increased capital requirements for big financial institutions "are important changes … this is progress that it's very important not to roll back."

Those battle lines drawn, Ms. Yellen also made it clear that she wasn't about to step aside for the new president – something some pundits had speculated about in light of Mr. Trump's harsh criticism during the campaign of the Ms. Yellen's low-rate policy at the Fed, flatly accusing her of orchestrating a stimulative rate policy to juice the economy to make his Democratic Party opponents look better. She will stick around as a possible thorn in Mr. Trump's side at least until her first term as chair ends in February, 2018 – a little over a year into the Trump presidency.

"I was confirmed by the Senate for a four-year term," Ms. Yellen said, adding that the cycle for Fed chair's terms and presidential terms are staggered "by design," to "reinforce the independence" of the Fed from political changes in power.

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"I'm a strong believer in the independent mandate of the Fed," she said.

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